Question

Describe the advantages or disadvantages of a particular Inventory Costing Method. When or why would you use one method over another?

Why is it important to take a physical inventory count? What could be some reasons for a discrepancy?

Answer 1

Last in first out (LIFO)

a. Pros

1. During times of inflation, LIFO results in a higher cost of goods sold and a lower balance of remaining inventory.A higher cost of goods sold means lower net income, which results in a smaller tax liability.

b. Cons

1. LIFO isn't a realistic inventory system and can be difficult to maintain.

2. Many international accounting standards don't allow LIFO valuation.

First in first out (FIFO)

a. Pros

1. FIFO is a more realistic inventory method than LIFO. Most companies try to sell their oldest inventory first to reduce the risk of obsolescence and spoilage, so costs are generally more accurate.

2. Helps the business with planning and forecasting.

3.  During times of inflation, FIFO has the effect of increasing the value of remaining inventory and increasing net income.

b. Cons

1. FIFO may not show an accurate depiction of costs when material prices rapidly increase.

2. Companies also suffer from missing the tax advantages of LIFO. Income tax is one of the largest expenses a company incurs, and a reduction can be a substantial financial benefit.

Importance of physical verification of inventory:

1. Ensures existence of assets of an entity

2. Facilitates valuation and rectification for any accounting discrepancy

3. To manage internal compliances of the entity

4. Critical for continuous customer service

Reasons for discrepancy:

1. Stock loss due to damage.

2. Stock is in the incorrect location.

3. Human error during stocktake process.

4. Stock loss due to theft.

5. Stock is labelled with incorrect identification.

6. Stock mistaken for similar product.

7. Inbound stock not recorded accurately